If asked, most people will likely say there are two ways to pay for major life expenses:
- Borrow money from your bank
- Pay for them with cash
But economist Nelson Nash, who coined the term “infinite banking”, begs to differ.
According to him — and many other financial experts — using a specially structured cash value life insurance policy as your personal infinite banking system is a much more efficient way to pay for major expenses.
Becoming your own banker gives you a greater control of your finances and brings you a step closer to financial freedom. Take a closer look at what infinite banking exactly is and how you benefit from it.
- The infinite banking concept involves buying whole life insurance, overfunding it, and using it as your personal line of credit
- You take out a policy loan instead of borrowing from a lender
- The cash value continues to grow over the policy’s lifetime, even while you are borrowing from it
- Infinite banking usually involves contributing 10% to 20% of your income to the policy each month
What is Infinite Banking?
Developed by R. Nelson Nash, infinite banking is a concept for becoming your own banker. The rationale is simple: You pay interest on all things you buy. Either you pay cash and lose the chance to earn interest on that sum or take out a loan and pay the lender interest. This means you are “financing” each thing you buy, by paying interest on a loan or not earning interest that you could have earned.
The infinite banking concept is a financial strategy that uses a special type of whole life insurance policy so that you can finance major purchases, invest money, or do both without borrowing money from a lender.
Instead of taking a loan and paying interest to a bank or financial institution, with infinite banking you take a loan using your life insurance policy’s cash value as collateral. In other words, your whole life insurance policy acts as a personal banking system — providing you with cash whenever you need it and at an interest rate lower than that of banks and lending institutions. You can use infinite banking to fund major expenses, such as:
- Your child’s education
- Student loan
- Car loan
- Down payment on a house
You will pay interest to the insurance company for the loan taken against the policy’s cash value, but the rate is usually lower than what banks charge. Additionally, you continue to earn interest or income on the cash value. This allows you to recapture a part of the interest that you would have lost.
But that’s not all. Your policy earns dividends, and its value continues to grow even when you are borrowing. In short, a well-funded whole life insurance policy allows you to set up your own personal infinite banking system.
The best part of infinite?
Your beneficiaries can use the proceeds of your policy to set up their own personal line of credit in the future. Their beneficiaries can also do the same and so forth. This is the reason why it is called the infinite banking concept..
Upon your death, your policy will pay the death benefit to your beneficiaries, who can use this money to overfund a whole life insurance policy and create their own infinite banking system.
How Does the Infinite Banking Concept (IBC) Work?
Infinite banking typically uses an overfunded participating whole life insurance policy. It not only accumulates wealth but also allows you to become your own banker.
What is an overfunded participating whole life insurance policy? It is a type of whole life plan where you contribute more premiums than are required for insurance coverage, so that your funds accrue more quickly. This gives you the opportunity to earn dividends.
While a standard whole life policy can help create a personal line of credit, it isn’t nearly as effective as an overfunded whole life plan. Compared to a normal whole life policy, participating whole life:
- Grows cash value more quickly (which means you will be able to take out a loan much sooner)
- Can potentially accumulate more cash value over time (which means you will be able to borrow more money)
Why use whole life insurance for the infinite banking concept?
Whole life is a type of life insurance policy that combines lifetime coverage with a cash value component. A part of each premium payment is used for accumulating cash value. Your policy’s cash value grows tax deferred, meaning you pay tax only when you access it, not during the growing years. As a policyholder, you can take a loan against the cash value any time once it has grown to a certain amount.
As mentioned before, infinite banking is a concept. To implement it, you need a tool. Whole life insurance is the preferred tool of choice for most people who want to become their own banker since it combines life insurance with an investment component.
- The insurance component serves as a financial safety net for your beneficiaries.
- The investment component helps you accumulate wealth in a tax-deferred way. The longer you hold on to the policy, the greater the cash value. Once the cash value is substantially high, you can take a policy loan against it and start enjoying the benefits of infinite banking. Plus, it will continue to grow even when you are using the money elsewhere.
Some people may argue that universal life insurance, which also combines death benefit with an investment account, can be a worthy alternative to whole life insurance In truth, using universal life insurance is not ideal because the cash value growth is dependent on the performance of underlying investment accounts.
While universal life insurance gives you a chance to accumulate more cash value when markets are up, the opposite is also equally true. This unpredictability makes universal life a poor choice for the infinite banking concept.
Participating vs. Non-participating Whole Life
Whole life insurance policies can be either participating or non-participating.
Participating whole life insurance policies, sold typically by mutual insurance companies, give you an opportunity to earn annual dividends. While dividends are not guaranteed and may vary in amount from one year to another, reputable companies have a solid track record of offering a sizable dividend almost every year. How you use these dividends is entirely up to you.
Non-participating whole life insurance policies, in contrast, do not earn dividends. As such, they are not the best fit for creating a personal life of credit.
To create your own personal banking system using life insurance, you must also overfund the policy. This means paying higher premiums with the idea of growing value quickly and later using it as collateral to secure a loan.
Pros and Cons of Infinite Banking?
As with all things, the infinite banking concept has pros and cons. While it is a great concept, it may not be for everyone. Before you put money into a sizable whole life insurance policy, it’s important to understand how this decision will affect you.
Pros of infinite banking
1. It's a Non-Correlated Asset
A non-correlated asset is isolated from the ups and downs of stock market, and as such offers a great way to protect your wealth from market volatility.
In addition, parking money in a whole life insurance policy is a great way to diversify your investment portfolio. A portfolio filled with assets susceptible to the same market events (think bonds, stocks, real estate, etc.) can be badly hit if that market were to take a major downward swing. Diversifying your investment portfolio can help generate more stable returns and protect you from losses.
Your cash value grows at a specific rate each year set by the life insurance company, regardless of market conditions. Also, participating whole life insurance pays interest-sensitive dividends. While it’s true that dividends are not guaranteed, note that some mutual insurance companies have been paying annual dividends on a regular basis for the past 100+ years.
2. Improves cash flow
Using a whole life insurance plan with your infinite banking strategy can help improve your cash flow. Usually, it doesn’t take more than a few days to receive a policy loan. In contrast, accessing the equity in real estate for example, is not as simple.
If you are in a cash crunch and want to tap into your cash value, all you need to do is call up the life insurance company and ask for a cheque. Since you are basically accessing your own money, the insurer will not neither run a credit check nor ask you to go through a lengthy application process.
3. Equity storehouse
When you use an infinite banking strategy, you put your equity into a tax-favored storehouse for future use. The cash in your storehouse grows through "true" compound interest. This is because you never touch your actual principle, but instead borrow from it. This allows your cash value to continue to grow with compounding interest, even as you pay simple interest, which can be fixed or variable, on the borrowed amount.
4. Guaranteed loan provision
Once your policy’s cash value grows to a certain amount, you can take a loan against it at any time — no questions asked, no evaluation, no hassle. With the infinite banking concept, you can convert a compounding asset into cash at a very short notice.
Of course, you can borrow against a brokerage account or real estate. With these assets however, you may not be able to turn them into cash in a financial emergency, and they aren't guaranteed to keep growing even while you are taking a loan.
5. Tax-advantaged growth
The cash value of your policy grows on a tax-deferred basis. You pay tax on it only when you access it, and then too only on the amount that exceeds the cost basis. Thus, the infinite banking arrangement allows helps you to accumulate more wealth since your money is not getting reduced by taxes every year.
6. Tax-free death benefit
Another pro of having a whole life insurance policy with your infinite banking system is that your beneficiaries are guaranteed to receive a tax-free death benefit upon your death. Your beneficiaries are free to use this money as they like, including for buying a participating whole life plan to set up a lifestyle banking system similar to yours.
Depending on the insurer, you could even tap into the death benefit while you are still alive. Most whole life insurance plans have a provision that allows the policyholder to access some or all of the death benefit if they are diagnosed with a serious illness. This provision is either offered as a free rider or a paid option.
7. Creditor protection
Unlike bonds, stocks, and brokerage investment accounts, life insurance is protected from creditors. Not only is the death benefit protected from the creditor, your policy’s cash value is also shielded. This means creditors cannot take the life insurance proceeds from your beneficiaries even if you have outstanding debts at death. Nor can they force you to surrender the plan for its net value to repay the debt.
Unlike brokerage accounts and banks, whole life insurance doesn’t show up on any credit reports. Nor does policy loans you take out to fund major purchases.
Apart from the above-mentioned benefits, participating whole life guarantees:
- Death benefit
- Cash value accumulation
- Level premiums
- Compounding interest rate growth
Cons of infinite banking
1. Monthly premiums can be high
The biggest downside of the infinite banking concept is the high cost of participating whole life insurance policy. Of the three most popular types of life insurance — term life, whole life, and universal life — whole life is the most expensive. On average, whole life insurance is 10 to 15 times costlier than term life. Participating life insurance plans also have higher premiums than non-participating.
The premium rate is based on many personal factors, like age, gender, health, and family medical history.
Since you would be paying the premiums of a whole life policy for the rest of your life or until you surrender coverage, set up an infinite banking system only when you are financially ready.
2. You must be insurable
Just because you can afford the cost of life insurance doesn’t mean you will get the kind of coverage you need. Whole life insurance policies are usually medically-underwritten, meaning you will have to give proof of good health.
As part of the life application process, you will have to answer certain health and lifestyle related questions, disclose your personal and family medical history, and undergo a medical exam. A serious pre-existing health condition can put a fully-underwritten policy out of your reach, so could a risky hobby, dangerous job, or criminal record.
Remember however, if one life insurance company rejects your application, it’s always possible that another company will rate you as insurable and offer the desired coverage.
3. Cash value grows slowly
Once you buy a whole life plan and start paying premiums, you will typically have to wait a few years before you can start borrowing against it. That’s because cash value grows gradually, and in the initial first years, there is not enough of it to go around.
4. You are expected to repay the borrowed amount
A policy loan is different from other loans in the sense that there is no compulsion on you to repay it in your lifetime. However, if you choose not to repay the loan, the life insurance company will deduct the outstanding amount from your death benefit, meaning your beneficiaries will receive less money than intended.
How to get started with infinite banking in Canada
Curious about how to take your first step toward financial freedom by setting an infinite banking system? You are not alone. In the recent years, infinite banking in Canada has become very popular among families as more and more people are looking for ways to reduce exposure to market volatility.
Here’s what you need to do sidestep traditional lenders and create wealth using a whole life insurance policy.
1. Start infinite banking as early in life as possible
Financial experts recommend buying whole life insurance when you are young. That’s because:
- Life insurance premiums rates are lowest
- Once set, your premium rate will not change during the policy’s lifetime
- It can take several years to accumulate the cash value you need to start borrowing money against it
2. Pick a financially stable insurance company
Life insurance is a long-term contract, so make sure you pick a provider that is financially stable.
The easiest way to check an insurance company’s financial stability is to check their ‘rating’. Many independent agencies, like A.M. Best, evaluate life insurance companies and publish their ratings online.
3. Choose a participating whole life insurance policy
While you can use any permanent life insurance policy with the cash value feature for infinite banking, participating whole life reigns supreme because:
- The investment component generates value at a guaranteed rate
- Once the cash value is meaningfully high, you can use it to finance purchases, like a car or a house
- Your cash value will continue to earn interest (and grow) even while you are leveraging it
- Many participating plans pay annual dividends almost every year, which can push your cash value accumulation further
- Upon your death, the insurer will pay your beneficiaries the death benefit, which they can use to fund their own personal banking systems
4. Opt for a paid-up addition rider
If you are using a participating whole life policy to become your own banker, opting for a paid-up addition rider may work to your advantage.
Your policy’s cash value acts as a personal line of credit, but the problem is that it takes several years to grow to sufficient levels to take out a loan. You can speed up cash value accumulation by using dividends — which only participating whole life pays — to buy additional coverage. As with the base policy, paid-up additional insurance earns dividends and accumulates cash value on a tax-deferred basis, meaning you will be able to enjoy the benefit of infinite banking in Canada sooner.
5. Start leveraging the cash value of infinite banking
Once your policy has enough cash value, you can start leveraging it by taking out policy loans. Just inform the insurer you want to borrow and the latter will likely process the request within a few days. Since your policy’s cash value serve as collateral, there is no screening process. Nor would the loan appear on your credit report. As far as the CRA is concerned, the borrowed amount is not an income, meaning you will receive it tax-free.
How infinite banking loans work:
- A policy loan is not taxable, as long as the borrowed amount does not exceed the cost basis and the policy remains in force.
- The life insurance company will charge you interest, since you are borrowing money from them instead of withdrawing directly. However, this interest rate is usually lower than what banks charge.
- The entire cash value continues to compound even while you are borrowing.
- If you have a participating permanent life insurance policy, you can use the annual dividend payments to boost the cash value growth further.
6. Repay the loan
At the end of day, a policy loan is a loan like any other. So, you will have to pay interest, though it is likely to be lower than that of a bank loan. You can take as long as you need to repay the loan or even choose to not repay it. However, any outstanding balance at the time of death will reduce the death benefit, meaning your beneficiaries receive a lower payout.
Is the Infinite Banking Concept worth it?
Becoming your own banker may sound exciting, but it isn’t for everyone. Generally, infinite banking in Canada is a right for people who have extremely strong cash flow. This is because whole life insurance costs several hundred dollars a month, and you will only be able to leverage your policy’s cash value several years after buying the policy
It's worth noting that infinite banking is just a concept. So even if you have a high net worth, you must implement the infinite banking concept correctly to benefit from it. This means overfunding a dividend-paying whole life insurance policy.
If the infinite banking concept doesn't sound like it's for you, don't worry, there are alternatives:
- Consider term life insurance: Term life insurance is 10-15 times cheaper than whole life on average. It is more than enough for most people who want to set up a financial safety net for their loved ones.
- Park your money in other tax-advantaged accounts: If you purchase a term life plan in place of a whole life, consider investing the difference into an RRSP or TFSA or both, to help you save for your retirement.
- Set up an emergency fund: Having a sizable emergency fund should be your top priority rather than starting on the infinite banking concept. Start by opening a high-yield savings account and gradually build it up until you have set aside 3-6 months’ worth of living expenses.
Infinite banking involves buying a specially-structured whole life policy, overfunding it, and using the cash value to fund major purchases and build wealth. To build long-term wealth using this strategy, you must make a considerable upfront investment. This option might not be feasible for the average person, but it can be highly successful for some.
If you want to set up infinite banking in Canada, Dundas Life can help you. Being an independent broker, we work for you — not the insurance companies. Reach out to schedule your free consultation today.
Frequently Asked Questions about the Infinite Banking Concept in Canada (IBC)